Trading in the FX market using mechanical trading strategies

Indicators Vs Price Action: Is One Better Than the Other ?

A seemingly never-ending debate in the field of technical analysis pertains to the tools used in order to get profit from the market. Is it better to use mere price action or indicators to create profitable systems and methods? The answer to this question isn’t trivial as it depends on what you define as an indicator, what you define as price action and the systems that you derive and measure by using these two tools. On today’s post I am going to talk about why there one is simply not better than the other and why it is usually a wrong perception to consider that one way of analyzing the market is intrinsically better than the other. In the end you’ll see that the success or failure of one technique against the other depends only on your level of understanding and how successfully you apply these tools to tackle underlying characteristics of the market.

What is an indicator and what is price action? Perhaps this is the first question we need to answer if we want to settle the discussion of which one is “better”. To many people making a distinction between the two seems like an exercise in futility since an indicator is merely a mathematical calculation over price values which makes it simply an alternative representation of the first. However – aside from what would be a more rational definition – when people talk about price action they talk about the analysis of pure characteristics of a price chart. For example analysis of candlestick lengths and shadow to body ratios (meaning candlestick pattern recognition) and price pattern recognition form the basis of what people would unequivocally call “price action” (PA). We could then interpret PA as the analysis of price considering all the elements that form each candle and indicator based trading as the reduction of this representation to some mathematically simplified form taking into account only a limited number of the pieces of information shown by PA.

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The second step is to compare some systems we know which use the two to see if one tactic leads to more successful systems over a large percentage of the time. In Asirikuy we have several indicator based strategies and price action based strategies which can be compared to look at their success. In summary what we find is that mechanical strategies developing both approaches yield good results and that none of the two is inherently better than the other. Both PA and indicator based trading can be used to derive profitable systems. It is not the particular tactic used that brings the profitability of the systems but the level of understanding behind this tactic which yields success.

For example Watukushay No.1 (now called Qallaryi) has a very successful portfolio (released today) which is as if not more successful than portfolios developed for Teyacanani (price action based EA). What makes Qallaryi and Teyacanani successful is that on both systems the tools were used in a way to exploit an underlying characteristic of the market (the development of trends) and any tool used for mechanical trading can lead to very successful systems if it is interpreted adequately. People generally have a misconception that PA is more successful simply because PA’s interpretation is much more straight forward and “easy to grasp” while the interpretation of indicators requires a true understanding of what the calculation tells you and how this information can lead to high probability predictions of future price movements. Of course when people see PA as easily interpretable after failing miserably to profit at a “do this when green arrow appears” system, then they see it as evident that PA is better than indicators. What they fail to realize is that to succeed with indicators a greater deal of understanding about PA in itself is needed as you need to understand how the calculations made by indicators are interpreted and lead to inefficiencies.

It is also a mistake to consider that PA can do things indicators cannot and the other way around. For example consider a system that enters trades when there are 4 consecutive bullish candles. To most people this would seem like a pure PA based system but you can achieve the exact same signals by trading the RSI(4) when it reaches 100. Many price action based strategies can in fact be turned into indicator systems (and vice versa) by using appropriately designed indicators for that purpose. Of course PA has the advantage of being able to take much more information into account while the advantage of indicators is the exact opposite (to be synthetic). Whenever you want to capture a result which is independent of the individual way in which candles develop (such as a clear breakout or a sudden move in one direction) then indicators are better because they allow you to remove degrees of freedom which are not needed for your strategy. However if you want to capture a particular type of event that does require specific price action to develop in some way then PA is the way to go. Both approaches can be very successful and which one is better merely depends on which one YOU understand better. In the end the important thing is how much you understand the tools you use and how they lead to the exploitation of market inefficiencies.

In my particular view both tools are very useful and perhaps the most powerful approach you can have involves the usage of indicators, PA and volume to make trading decisions. You need to have an understanding of what is happening in several dimensions to have the highest degree of possible success and indicators, PA and volume allow you to have a very holistic understanding of what is going on if you know what the indicator calculations mean and you can actually interpret them correctly. IF you are trading the Stochastic just because it crossed X level then you are doomed to failure with indicators as you need to interpret the information given by the indicator through the lens of what it truly tells you. For example you may look at the 20 period Stochastic at 80 an realize that this means you are close to the 20 period high (80% of the distance between the low and high) and if a candle with a large shadow towards the upside forms and closes then you realize that a reversal might be imminent, however since the 200 period stochastic is also high you realize you’re in an up trend so the retracement might just lead to a better chance to enter a trend continuation. It is your ability to understand and interpret what brings success NOT the tools you’re using.

What is better? What you understand better. What is best? To understand everything! If you would like to learn more about my work in automated trading and how you too can learn how to create and use automated trading systems based on sound trading tactics please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach towards automated trading in general . I hope you enjoyed this article ! :o)

2 Responses to “Indicators Vs Price Action: Is One Better Than the Other ?”

Great article ;) I agree understanding is ultimately the key to the success of any system. I wonder, would you make a further distinction between PA that can be systematically recognised (eg candle patterns) and PA that requires significant user interpretation (eg support and resistance lines)? Obviously both still rely on the experience and understanding of the trader to trade successfully, as you say, but while any two traders can agree on the calculation of a candlestick pattern they will rarely agree where support and resistance lies. The reason I ask is because while Asirikuy systems do a phenomenal job of identifying inefficiencies using both indicators and PA, I think this ‘third’ category of highly interpreted PA presents a much greater but intriguing challenge for automated trading systems.

Thank you for your comment :o) I do not think that there is a separate “PA category” which encompasses to hard to interpret trading techniques but mainly this form of trading – discretionary trading – forms a completely different category. The move of such concepts to numerical means is bound to be complex and quite interesting but I do not think that it may lead to better results than the currently implemented PA or indicator techniques. If this was the case then profitable discretionary traders would out-profit algorithmic traders by big amounts something which is not the case (see Barclay mechanical Vs discretionary currency trader index). Certainly there is room for improvement as our understanding becomes higher and we achieve better synergism between PA and indicators and including techniques which are difficult to define mathematically in a clear way is something which I have been doing implicitly with some neural network experiments. It is quite curious that NN techniques tend to trade as if they were “aware” of support and resistance and gartley patterns such as “bats” and “butterflies”. It will be very interesting to study this phenomena more in depth. I hope this answers your questions Sam :o) I am very glad to see you’re liking the blog !